In the Land of the Blind, PJB Is King of the Banking ETFs

As the banking sector buckled under the weight of bad real estate loans, PowerShares Dynamic Banking ETF (PJB) rose to the top of our Sector Momentum Charts. In the last three months, PJB’s market return has outperformed the S&P 500 by more than 28 percent. In the last month alone, as Lehman collapsed and Goldman (GS) and Morgan Stanley (MS) transformed into bank holding companies, PJB’s market return outperformed the S&P 500 by 15.38 percent. This performance pushed PJB up our charts, from the No. 60 position on July 16 to the top position overall on September 30.

PJB tracks the Dynamic Banking Intellidex Index, which evaluates banking equities based on fundamental growth, stock valuation, investment timeliness and risk factors. Using these factors, the Dynamic Banking Index selects “best of breed” banks for inclusion in the portfolio. While an examination of PJB’s top ten components reveals many of the usual suspects—Wells Fargo (WFC), JPMorgan Chase (JPM), U.S. Bancorp (USB) and Sun Trust (STI)—other, smaller banks have helped PJB to weather the financial crisis better than the sector as a whole. More than 50 percent of PJB’s components are classified by PowerShares as small cap. While the tempest stirred up by mortgage practices has dealt a blow across the banking sector, PJB’s concentration in small cap value has spared this fund some of the pain suffered by the larger banks in the headlines.

In light of recent turmoil in the banking industry, the most unnerving aspect of any banking index is its ability to transform in line with market conditions. While the number of shares allocated to any one component can be adjusted on a day-to-day basis, major index changes—dropping or adding a component stock—are made on a quarterly basis. A passive indexing approach is extremely beneficial for emotional investors who tend to buy high and sell low, but it is nevertheless difficult when you are synthetically long on one stock—because of its inclusion in an ETF’s portfolio—and you can’t get rid of this exposure until the fund’s quarterly rebalancing.

In the case of PJB, major portfolio reallocations in 2008 proved to be beneficial for investors plagued by financial turmoil. PJB changed the composition of its portfolio in March, June and September of 2008, allowing fund managers to remove poorly performing banks and reallocate assets to banks that were performing relatively better when measured by the fund’s investment criteria. During a year of constantly changing banking industry news, these shifts have been responsible for the noteworthy performance of the fund. In relatively calm quarters, ETFs may only slightly adjust portfolio holdings—if at all—but PJB’s massive portfolio overhauls in March, June and September illustrate the changes going on in the sector as a whole.

In March, the landscape of PJB’s portfolio was dramatically altered as 13 component changes were made to the portfolio. In this wave of alterations, PJB removed Bank of America (BAC), KeyBank (KEY) and Zions Bancorporation (ZION), among others—adjustments that would prove to be beneficial to investors in the months to come. Notable June changes included the addition of First Financial Bancorp and the removal of Wells Fargo—a move that would be reversed come September. In addition to adding Wells Fargo back into the mix this past month, PJB also welcomed BB&T (BBT) and Provident New York (PBNY)—two small banks that have thrived in recent conditions.

The removal, and subsequent reinstatement, of Wells Fargo—now PJB’s top component at 5.45 percent—is arguably the biggest shift in 2008. When we last profiled PJB in April, Wells Fargo comprised only 4.91 percent of the portfolio. Wells Fargo’s star has shined brighter in recent months as a flight to safety, and a willingness to pay more for any type of reasonable credit has driven investors to scoop up shares. Wells Fargo’s net interest margin has actually grown in the last quarter—from 4.89 percent to 4.92 percent—a welcome statistic in the midst of recent industry chaos. PJB has accounted for WFC’s value nicely, and the addition of this product in September has helped to boost the fund’s returns.

As banking news hits the headlines almost every day, PJB’s shares outstanding have grown dramatically in size, from 6.8 million on March 1 to 8.8 million on September 30. This increase has been particularly notable in the last month, as the number of shares outstanding increased by nearly 3 million. The creation of additional shares of PJB is beneficial to average investors who own the fund. A larger number of shares outstanding can provide more liquidity in the open marketplace, making the fund easier to buy and sell during the day.

Many investors will be hesitant to enter the banking sector in light of the current financial crisis. The growth of PJB’s assets, however, tells a slightly different story. While panic has consumed the banking industry as a whole, PJB has stuck to its guns—sticking to higher quality large-cap banks and small-cap banks that can be rebalanced aggressively when market conditions warrant. As more units of PJB are created in the marketplace, it has become increasingly evident that a growing number of investors see this fund as a reasonable way to participate in bargain equity prices.

Comments

[Brian in Mo...:]

Very interesting, Thanks.

2008 Oct 03 07:22 AM

[legmaker:]

Great information and God Bless

2008 Oct 20 12:23 PM